Good news as the Bank of England’s Monetary Policy Committee (MPC) voted to once again hold its base rate steady at 0.1%. This comes a day after the US Federal Reserve Board, the equivalent rate-setter for the US, voted to also leave rates untouched.
After months of warnings that a rates rises was imminent, with inflation now well above the Bank’s 2% target, this was a wise decision by policymakers. As the Bank’s governor, Andrew Bailey, has previously pointed out, with inflation coming in from the shocks to supply over the last 18 months or so, there is little fiddling with interest rates can immediately do:
In considering how to use monetary policy, it is also important to understand the nature of the shocks that are causing higher inflation. The shocks that we are seeing are restricting supply in the economy relative to the recovery of demand. This is important because monetary policy will not increase the supply of semi-conductor chips, it will not increase the amount of wind (no, really), and nor will it produce more HGV drivers. Moreover, tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy.
He’s absolutely right: interest rate rises would do little to dampen the inflation we have today, but would hurt the economy more generally. But this didn’t stop Bailey making hawkish noises over the last few months. Nor did it stop the Bank’s new chief economist, Huw Pill dropping very substantial hints to the FT that he was minded to push for rates rises.
Nonetheless, by a 7-2 vote the MPC’s great and good – which include Bailey and Pill – have decided to hold off on interest rates, no doubt helped along by the Fed’s decision. Not everyone is happy. Some of traders lured into thinking they had a one-way bet on Bank of England rates rises have been whinging to the press, claiming that Bailey’s “credibility” would now be on the line.
Pressure will be on the MPC to shift rates upwards at their December meeting, since it is wholly unlikely that inflation will be coming down any time soon. But it must be resisted: the far bigger risk to the Bank’s “credibility” is, as Charles Goodhart and Majoj Pradhan have argued, if the Bank decides to incrementally raise interest rates but fail to materially influence inflation – as it surely would do.
Bailey has let it be known that rates rises will be heading down the line “in coming months”. But if the logic of holding steady today – that inflation is the result of supply factors, not demand – the same will hold in a few months’ time. For those who take a pessimistic view of likely future supply constraints, the same will hold at any point in the foreseeable future.
Interestingly, the Bank itself also looks increasingly pessimistic. Its forecasts for damage from covid-19 have been revised upwards, to the (in my view, still far too low) level of a 2% permanent loss to GDP from the virus, up from 1% and matching the Office for Budget Responsibility’s assumptions. And the Bank’s view of supply growth in the medium term is low, set at 1.75% as compared to 2.75% it has been estimated as in the decade before the financial crisis.
As this reduction in potential growth suggests, the economic slowdown had happened before covid. What seems likely (although the Bank do not yet accept this) is that covid, alongside the growing frequency of extreme weather, crop failures, and further disease outbreaks as the planet’s climate changes will all turn into hard barriers to supply growth (and therefore long-run growth overall) in the near future. Either way, its short-run forecasts for growth have been revised down for the next four years, hitting just 1.1% growth by 2024 (Table 1.A).
